Europe takes first stab at building banking union

BRUSSELS The fate of the European Union's banks, struggling to ride out the debt crisis, will take centre stage on Friday when ministers turn to the question of forging a banking union, a crucial step to stand behind their troubled lenders and the euro.

Although the 17 countries in the euro zone share a single currency, their governments set their own economic course and have been left to resolve their national banking problems.

"The new focus is on the banks and integrating (the response) that reflects the situation on the ground and the situation in Spain," one senior diplomat said ahead of the meeting of EU finance ministers in Luxembourg on Friday.

EU leaders will examine proposals next week at a summit meeting in Brussels for a process of integration that may seek to centralise economic decision-making in the euro zone.

Although it is likely to take years to realise, they hope that by embarking on this course, investors will be reassured about the euro's future.

Establishing a banking union - with a single supervisor for big banks, a fund to wind down cross-border lenders in trouble and a common deposit guarantee scheme to protect savers - will be the first move in this direction.

"In a way, it may be easier to move on banks," the diplomat said. "Banks is a technocratic affair, contrary to fiscal policy, which is bound up in national history and identity."

Ministers from countries in the euro zone, who meet on Thursday, may receive an application for up to 100 billion euros in assistance to Spain to shore up its flagging banks, one diplomat said. This would give further momentum to the debate.

But more contentious is the issue of a banking union, which will likely shift power from national regulators to a higher authority, such as the European Central Bank (ECB).

"We are talking about very intrusive powers," said a second diplomat close to the discussions. "Who will have those powers?"

"We need tools, we need money. We are also talking about solidarity, so that national bank funds are obliged to loan to other countries if they need it," he said.

One of the biggest divisions in the debate about such a union is whether it will apply only to countries in the euro zone, or to all 27 member states in the European Union.

Britain has said it will not join such a scheme, which it believes should be limited to the single currency area.

The European Commission, the EU's executive, wants the union to apply to all countries, because of concerns that scaling it back would undermine the bloc's borderless single market.

"UNANSWERED QUESTIONS"

Michel Barnier, the EU commissioner in charge of financial regulation, will attend Friday's meeting to appeal again for all countries to join.

"There are still a lot of unanswered questions, not least whether it is going to be a banking union of 27 or 17," said Fabian Zuleeg of think-tank the European Policy Centre.

"Not having the UK can create lots of problems in the future. It would be a further step in the drifting apart of the UK from the rest of the European Union."

The executive European Commission intends to build on a draft law to make it easier to close problem lenders with proposals to strengthen the monitoring of banks.

It has outlined a law to link individual country deposit protection schemes or funds to wind down lenders. It may propose the creation of a single combined pan-EU scheme.

Barnier has said that many elements of the banking union could be in place within a year. But some analysts believe that will be too late to help countries in difficulty, like Spain.

"While it is all very well talking about a future banking union, we have a banking problem to solve right now," said John Fitzgerald, of the Economic and Social Research Institute, a Dublin-based think-tank.

The talks in Europe are keenly watched by foreign investors, many of whom are disappointed by the slow European response especially when compared to the United States.

"My expectation is that it is going to take a long time," said Eric Stein, of Eaton Vance Investment Managers, a U.S. investor in European bonds. "Everything in Europe seems to take a while."

(Reporting by John O'Donnell; Editing by Rex Merrifield and Catherine Evans)

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